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Friday, July 27, 2012

Agency Shortcuts and Shortfalls

Investors in certain "AAA" resecuritizations won't be happy. Late last night, Moody's downgraded a bunch of securities, even though they are supported by Agency-guaranteed RMBS.

Many of these were downgraded from Aaa to junk (some at Ba1, others all the way to B1) in one fell swoop, while others went only to A1. (It looks like S&P still carries most of these securities at AA+, which is lower than Moody's Aaa as S&P has downgraded the United States to AA+.)

What's most interesting here is the reason. It's not the case that either Fannie or Freddie hasn't paid up on their guarantees, but it looks like the deals may not have been modeled (possibly ever!) - or at least may not have been modeled correctly. According to their press release, the resecuritization vehicles seem not to have the necessary protections in place to support the bonds issued, or the ratings provided. Some of these deals were structured in 2007 and even late 2008. Many of these deals are already suffering shortfalls.

From Moody's press release:

"The downgrade rating actions on the bonds are a result of
continual interest shortfalls or lack of adequate structural mechanisms to
prevent future interest shortfalls should the deals incur any extraordinary
expenses."

... and ...

"Interest due on the resecuritization bonds is not subject
to any net weighted average coupon (WAC) cap whereas interest due on some of the
underlying bonds backing these deals is subject to a net WAC cap."

... and ...

"Since the coupon on the resecuritization bonds is
currently higher than that of the underlying bonds, the resecuritization bonds
are experiencing interest shortfalls which on a deal basis are accruing
steadily."

Total issuance of $483mm affected, according to Moody's. Deals are of Structured Asset Securities Corp. and Structured Asset Mortgage Investments shelves.

1) for those bonds that have already suffered shortfalls, remember Moody's rating speaks to "expected loss" not probability of default. So even if default is certain, as long as recovery is high (or full) upon default a high rating may still be appropriate.

2) if you're asking about why S&P doesn't rate this D, that's also a fair question - and the answer is they may still downgrade it to D, they may just not have done this yet. Having said that, even though they conceptually have something closer to a "Default Probability" rating, it's no longer quite that anymore. They have recently changed the meaning of their ratings to incorporate more than just default probability. Essentially, they're credit risk ratings - not just default risk. For more on this, visit their ratings definitions here (or let us know and we'll be happy to walk you through what's meant by their ratings).